Property Exit Strategies

The 1031 exchange allows you to defer your capital gains tax by rolling the sales proceeds from the original property into the next one (like-kind exchange)

 

This process is often called "trading up" as you'll usually purchase a bigger or better property.

 

For example, if you would have to pay $100,000 in capital gains tax, you can defer paying that tax if you roll the sales proceeds into another property.

 

The $100,000 now provides another $400,000 in buying power using a standard 75% LTV ratio.

 

And if you continually use 1031 exchanges throughout your life, your heirs can receive the property the FMV of the property at the date of your death - eliminating the capital gains taxes you would have paid had you sold the properties yourself.

​

In Rare circumstances, A “reverse” exchange occurs when the taxpayer acquires the replacement property before transferring the relinquished property. A “pure” reverse exchange, where the taxpayer owns both the relinquished and replacement properties at the same time, is not permitted. The IRS has provided guidance on structuring a reverse exchange, offering a safe harbor under Rev. Proc. 2000-37. An Exchange Accommodation Titleholder (EAT), acquires and holds the target property (the parked property) in a separate special purpose entity, typically a single member LLC (the EAT and LLC are jointly referred to as “EAT”). To complete a reverse exchange, the EAT will take title to either the Relinquished Property or the Replacement Property under a “Qualified Exchange Accommodation Arrangement” (QEAA).

Passive losses from rental real estate can offset capital gains from the sale of rental real estate.

 

The strategy here is to acquire one or more rental properties in the same year you sell a rental property.

 

Then have a cost segregation study performed on the new property.

 

This will generally generate a significant loss on the property thanks to bonus depreciation.

 

The loss is then used to offset the capital gain on the sale of your property.
 

The installment sale allows you to sell a property and collect payment over a number of years.

 

While depreciation recapture taxes are generally due in the year of the sale, this spreads the capital gains tax out over the years of the installment sale.

 

The benefit to doing this is it can keep you from creeping into a higher capital gains bracket in the year of the sale, avoid NIIT, and keep your MAGI below certain thresholds that can impact health, retirement benefits, and other tax credits/deductions.

 

Other benefits include the ability to collect an additional stream of income in the form of interest by acting as the bank.

The 2017 Tax Act adopted special benefits for taxpayers looking to prevent taxation of capital gains, which will also assist the real estate market in 1,000s of economically distressed communities across the country.  The IRS recently released proposed regulations and guidance, which are helpful and should stimulate use of this new tax motivated investment option.  If an investor recognizes a long term capital gain (“LTCG”) from the sale of stock or other assets and within 180 days of the sale, the investor makes a cash investment equal to the LTCG in a Qualified Opportunity Zone (“QOZ”) Fund then the investor can get the following tax benefits.

​

First, the taxpayer can elect to defer recognition of the LTCG until the earlier of (1) the date the taxpayer sells their interest in the QOZ Fund or (2) 2026.  Also, unlike a §1031 tax-free like-kind exchange , there is no requirement to invest the entire sale price in the QOZ Fund to get tax deferral; the taxpayer only has to invest the gain to get tax deferral.

​

Second, there is a permanent reduction in part of the deferred LTCG from the original investment if the investment in the QOZ Fund is held for at least five years before sale.  If the QOZ Fund investment is held for 5 or more years, then the deferred gain will be reduced by 10%.  If the QOZ Fund is held for 7 or more years, the deferred gain is reduced by 15%.  Also, whenever the deferred gain is recognized, the tax basis of the QOZ Fund is increased by the gain that is then recognized. 

​

Third, if the investor has patience and can delay the sale of their interest in the QOZ Fund until they have held the investment for 10 years or more then the tax basis of the investment is increased to the fair market value of the investment on the date of sale.  This “step-up” in tax basis effectively eliminates any federal income tax on the sale.  These tax benefits will stimulate long-term investments in QOZ Funds.

​

What is a QOZ?  A state can designate any economically distressed area as a QOZ, which can include select parts of cities and townships.  The U.S. Treasury Department must then consider whether to certify that designation as being a QOZ.  A map showing certified QOZs is available on the internet, https://www.cims.cdfifund.gov/preparation/?config=config_nmtc.xml.  Around 8,000 areas have been designated as QOZs.

​

What is a QOZ Fund?  A QOZ Fund is a corporation or partnership if 90% or more of its assets consist of QOZ Property, as described below.  Unlike prior tax programs that were targeted to housing (e.g., low income tax credits), the QOZ Fund can invest in QOZ commercial real estate or any trade or business such as an operating business located in the QOZ.  Thus, they are more flexible.  A QOZ Fund self certifies its compliance with applicable requirements on Form 8996.  As a result, an investor in a QOZ Fund needs to be confident that the fund qualifies as a QOZ Fund. 

​

QOZ Property is QOZ Business Property, QOZ Partnership Interests or QOZ Stock.  QOZ Business Property is tangible property located in the QOZ that was acquired by purchase from unrelated parties; other conditions also need to be met.  QOZ Partnership Interests and QOZ Stock are investments in partnerships and corporations that meet certain conditions aimed at making sure they benefit the QOZ.